Realty Income Corp (O), Health Care REIT, Inc. (HCN): Which of These REITs Is Cheap Enough to Buy?

One asset class that has received extra attention from investors over the past year, because of their tendency to provide market-trouncing dividend yields, is real estate investment trusts (REITs). These companies invest in real estate properties, and can offer such attractive yields because they are required to distribute 90% of their income to shareholders as part of their favorable tax structures.

Many REITs are on a tear since the beginning of the year, and I’ve written critically in the recent past that the huge rallies seen in many REIT had gone too far, too fast. After considerable retracements over the past several weeks, are these REITs finally ripe for the picking?

Were the astounding rallies a mirage?

REITs aren’t supposed to be construed as growth stocks. The investment case for REITs has traditionally been focused on the reliable income they provide.

At the same time, over the past year many publicly-traded REITs have skyrocketed in price, defying their slow-and-steady reputations. One of the most popular REITs in existence, Realty Income Corp (NYSE:O). shows a chart more befitting of a high-flying technology start-up than a yawn-inducing REIT.

Realty Income Corp (NYSE:O) ended 2012 as a $40 stock. By May, it reached $55 per share. That means in just five months, Realty Income Corp (NYSE:O) racked up 37% gains, which don’t even include the generous dividends that REITs like Realty Income are known for.

This perplexing case of a REIT skyrocketing in value wasn’t a one-off. This was a pattern seen broadly throughout the REIT landscape.

Health Care REIT, Inc. (NYSE:HCN), which, as you can probably infer, manages health-care related properties including hospitals and senior living communities, also shot up in value to begin the year.

Health Care REIT, Inc. (NYSE:HCN) began 2013 trading for $61 per share, then shot up to nearly $80 per share in just a few months’ time.

Of course, as a company’s share price climbs, so does its valuation. And, since REITs historically have grown profits at modest paces, I became worried about the lofty prices investors became all-too-willing to pay for these stocks.

When I last wrote about Realty Income Corp (NYSE:O) and Health Care REIT, Inc. (NYSE:HCN), both stocks were trading for alarmingly high valuations. On a price-to-FFO (funds from operations, a metric commonly used in place of EPS for REITs) basis, Realty Income Corp (NYSE:O) and Health Care REIT, Inc. (NYSE:HCN) traded for 27 and 22 times trailing FFO. And, indicative of REITs’ slow-growing nature, both stocks traded in excess of 20 times forward FFO as well.

The joyride didn’t last very long. Many REITs sold off when interest rates began rising last month. Fears of Fed tapering served as further fuel on the fire, and before long, Realty Income and Health Care REIT fell back to more reasonable levels.

At their current levels, Realty Income Corp (NYSE:O) and Health Care REIT, Inc. (NYSE:HCN) have retraced much of the gigantic gains seen this year. Their dividend yields are approaching 5% again, the level I personally prefer to see for REITs.